Issue
Are legal expenses incurred in pursuing a breach of a contract for sale allowable as a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?
Decision
No. The legal expenses incurred in pursuing a breach of a contract for sale are not allowable as a deduction under section 8-1 of the ITAA 1997.
Facts
The taxpayer was a member of a partnership that carried on a business. The partners attempted to sell the business. An offer was made for the business and a deposit paid. The offer was withdrawn. Legal expenses were incurred with regard to possible action against the buyer for breach of contract.
Reasons for Decision
Section 8-1 of the ITAA 1997 allows a deduction for all losses or outgoings to the extent that they are incurred in gaining or producing assessable income or are necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. However, no deduction is allowed to the extent that the losses or outgoings are of a capital, private or domestic nature or are incurred in gaining or producing exempt income.
While the legal expenses were incurred by the taxpayer in connection with their business, legal expenses are often considered by the courts to be capital in nature. In Case AAT Case 5596; AAT Case X3 90 ATC 114; (1989) 21 ATR 3154, two partners operated a business. The partners decided to terminate the business and dispose of the premises. A sale was proceeding until the purchaser withdrew. The partners sought legal advice as to whether they could take action against the purchaser. Senior Member R A Balmford confirmed the Commissioner's submission that the legal expenses were of a capital nature and thus not allowable as a deduction.
The legal expenses were incurred in the sale of the business and are therefore capital in nature. A deduction is precluded by section 8-1 of the ITAA 1997.